Simplifying the Taxation of Pensions

The recent Pensions Green Paper has recognised that the tax system for pensioners is so complex that it discourages saving and imposes a huge administrative burden on employers and employees. This study by actuaries Philip Booth and Deborah Cooper welcomes the proposals in the Green Paper as an important step forward. Simplifying the Taxation of Pensions argues that greater benefit and greater simplicity would arise from creating one tax regime for defined benefit pension schemes and a parallel one for defined contribution schemes, which would replace the labyrinthine collection of tax rules and codes that currently exists. Whole rafts of regulations could then be abolished and serious disincentives to save in pension schemes would be removed.

Booth and Cooper comment, "Our calculations show that pensions funds do not enjoy the tax-favoured status often assumed, particularly since the abolition of reclaimable dividend tax credits in July 1997. Therefore, the Inland Revenue has little to fear from the lighter- touch tax regime that would result from these proposals: but there is much to be gained." The authors also argue that it would be better to abolish the tax-free lump sum and use the money to restore dividend tax credits to make equity returns in pension funds tax-free once again. In this context the paper argues that "buy-one-get-one-free" (BOGOF) proposals, recently proposed by a number of commentators, would increase the complexity of the pensions system.

Booth and Cooper also propose that rules requiring compulsory purchase of annuities should be reformed. The current rules are designed to prevent tax abuse and date from a time when marginal tax rates were much higher and pensions were tax favoured to a greater extent. Annuitisation rules should be developed that simply prevent those who have made pension provision from relying on means-tested state benefits.